Gutting: The Meaning of 'Limited Partner' in the Internal Revenue Code

Kristin Balding Gutting (Charleston), Keeping Pace with the Times: Exploring the Meaning of Limited Partner for Purposes of the Internal Revenue Code, 60 U. Kan. L. Rev. 89 (2011):

This article explores the use of the term “limited partner” within the passive loss rules of § 469 and the corresponding Treasury Regulations in light of the always changing business environment. The passive loss rules of § 469 turn on whether a taxpayer materially participated in the loss generating activity. The preferential nature of several Code provisions turns on whether a person is a limited partner, the majority of these references being codified within the Code prior to the creation of many new types of entities, including the LLLC, the LLP, and the LLLP (collectively referred to as a Limited Liability Entities). The term was placed in to the Code when the only entities taxed as partnerships were general partnerships and limited partnerships. At such time, a limited partner was essentially prohibited from participating if the limited partner wanted to maintain his limited liability status. However, this article asserts that in today’s business environment, a trend is developing where the distinctions between an individual’s ability to participate in Limited Liability Entities and maintain limited liability has become blurred. Under the special rule of § 469(h)(2), if a taxpayer is a limited partner, deducting certain losses is subject to more stringent rules. For almost twenty years, the IRS has been asserting in audits that an interest in Limited Liability Entities should be treated as a limited partner for applying § 469. In late 2009, however, the Tax Court held that an LLC member and an LLP partner were not limited partners for purposes of the passive loss rules. Shortly thereafter, the Court of Federal Claims reaffirmed that for purposes of the passive losses rules LLC members were not limited partners. The Court of Federal Claims, nevertheless, did not address the application of § 469(h)(2) to an LLP. Accordingly, it is still unclear whether under § 469(h)(2) a partner in an LLP and/or an LLLP is considered a limited partner. Essentially, this has led to the belief by scholars and practitioners that the issue is resolved concerning an LLC. Yet, in December 2010, the Service commented that it would issue guidance in this area. Furthermore, both the Tax Court and the Court of Federal Claims hinted that the Service could amend the Treasury Regulations to explicitly include Limited Liability Entities as being subject to the more stringent rule of § 469(h)(2). This article proposes that the Service should not amend the regulation, but, instead Congress should revoke § 469(h)(2), as in today’s business world there has been a change of circumstances, and the Code must advance to keep pace with the times.